409A valuations: what they are and how they work
Short answer
A 409A valuation is an estimate of the fair market value of a private company's common stock, used to set stock option exercise prices at or above fair market value on the grant date so the options are exempt from Section 409A's penalties. The Treasury regulations presume a valuation reasonable if it uses one of three methods, most commonly an independent appraisal dated no more than 12 months before the grant. Material events can make an older valuation stale sooner.
If your company grants stock options, someone has to decide what the common stock is worth on the grant date. Set the price too low and employees can face a tax problem years later. A 409A valuation is how private companies make that call defensibly. This isn't tax advice; confirm how the rules apply to you with your tax adviser.
Why it exists
Section 409A of the Internal Revenue Code governs nonqualified deferred compensation. Under the Treasury regulations, a stock option is exempt from 409A if, among other conditions, its exercise price can never be less than the fair market value of the underlying stock on the grant date. For public companies, the market sets that value. For private companies, the regulations say value must be determined by the reasonable application of a reasonable valuation method, and they give three methods presumed reasonable (the "safe harbors").
The three safe harbors
Treas. Reg. 1.409A-1(b)(5)(iv)(B)(2) presumes these methods reasonable, unless the IRS shows the method or its application was grossly unreasonable:
| Safe harbor | Key conditions (paraphrased) |
|---|---|
| Independent appraisal | Determined by an independent appraisal meeting the requirements of section 401(a)(28)(C), as of a date no more than 12 months before the grant |
| Binding formula | A formula that would be FMV under a nonlapse restriction, used consistently for transfers to the issuer or 10%+ holders (with exceptions) |
| Illiquid start-up | Written report, reasonable and in good faith, for a company with no material business conducted 10 years or more and no traded equity; performed by someone with significant knowledge and experience (generally at least five years); not if a change in control within 90 days or an IPO within 180 days is reasonably anticipated |
Details and caveats in 409A safe harbors.
What a valuer considers
The regulations list factors a reasonable valuation takes into account, including the value of tangible and intangible assets, the present value of anticipated future cash flows, market value of comparable businesses' stock, recent arm's-length transactions in the company's stock, control premiums or discounts for lack of marketability, and whether the method is used consistently for other purposes. A valuation also isn't reasonable if it fails to reflect information available after its date that may materially affect value, such as a new financing round or a big contract.
How the value is estimated
- Value the whole company (enterprise or equity value) using income, market or asset approaches, or by back-solving from a recent priced round.
- Allocate value across share classes, because preferred stock has liquidation preferences and other rights. Common methods include option-pricing models, probability-weighted scenarios and hybrids.
- Apply a discount for lack of marketability to the common stock, since it can't easily be sold.
- Conclude a per-share fair market value for common stock as of the valuation date.
Plain-English explanations in 409A valuation methods.
When to get one
- Before the first option grant.
- When the prior valuation is approaching 12 months old.
- After a priced financing round, secondary sale, acquisition offer, major contract, or anything else that may materially change value.
- When an IPO or sale becomes reasonably foreseeable (the start-up safe harbor stops applying).
See how often to update and the process.
What it costs and who to hire
Fees depend on stage, capital structure complexity, number of share classes, whether a recent round exists to back-solve from, and turnaround. We don't quote market price ranges without a source. Choosing a provider: 409A providers, and cost drivers.
Regulatory references checked against the eCFR and Cornell LII text of 26 CFR 1.409A-1 on October 25, 2026.
How startup valuations feed the 409A
Most startups are valued by negotiation in a priced round: investors pay a price per preferred share, which implies a post-money valuation. That headline number is not the value of common stock. For option grants, a 409A valuation estimates the fair market value of common, which is usually well below the preferred price because preferred carries liquidation preferences and other rights. The round is a key input to the 409A.
Illustration, not a real company.
| Pre-money valuation | $8,000,000 |
| New investment | $2,000,000 |
| Post-money valuation | $10,000,000 |
| Investor ownership | $2,000,000 / $10,000,000 = 20% |
| Fully diluted shares after round | 10,000,000 |
| Preferred price per share | $1.00 |
Methods you'll hear
- Priced round: the market price set by investors for preferred shares.
- Venture method: estimate exit value, divide by the target return multiple to get today's post-money.
- Comparable rounds: what similar companies raised at.
- For 409A: a backsolve from the latest round, then allocation across share classes (see 409A methods).
Why preferred and common differ
Preferred stock in a venture round usually carries a liquidation preference: in a sale, preferred holders get their money back (sometimes more) before common holders see anything. It may also have anti-dilution protection, board seats and veto rights. If the company sells for less than the total preferences, common may get little or nothing. A 409A valuation models those rights across possible outcomes, which is why the common value comes out below the round price even when the company's total equity value is consistent with the round.
Illustration, not a real company. Investors hold $10,000,000 of 1x non-participating preferred. If the company sells for $8,000,000, preferred takes all of it and common gets nothing. If it sells for $50,000,000 and preferred converts to common, everyone shares pro rata. Common's value today depends on how likely each outcome is, and when.
SAFEs and convertible notes
Many early companies raise on SAFEs or convertible notes before any priced round. These don't set a share price directly; they convert later, often at a discount or subject to a valuation cap. For a 409A they're still part of the capital structure, and a valuation cap can be a useful, if imperfect, signal of what investors believed the company was worth.
How often the number changes
A startup's headline valuation changes when it raises money; its 409A value changes more often. The regulation treats a valuation as stale after 12 months, and earlier if it fails to reflect material new information. Founders granting options regularly should expect a 409A refresh at least yearly and after each priced round, a significant convertible financing or an acquisition offer. See how often to update a 409A.
Common founder mistakes
- Treating the post-money valuation as the value of common stock.
- Granting options after a term sheet is signed using the old 409A value.
- Leaving SAFEs and notes out of the cap table given to the valuer.
- Assuming a low 409A is always better; an unsupported value undermines the safe harbor.
When startup valuation meets lending
Startups rarely fit SBA acquisition lending, which requires historical cash flow covering debt service. Where OKtoLend's 409A and SBA work meet is later: a profitable founder-led company that once needed 409As may eventually be sold to a buyer using an SBA loan, and the earnings history, not the venture valuation, will set the price a lender can support.
The 409A start-up presumption
For a company with no material trade or business conducted for 10 years or more and no publicly traded equity, a written valuation by a qualified person (generally at least five years of relevant experience) is presumed reasonable, unless a change in control is reasonably anticipated within 90 days or an IPO within 180 days. See 409A safe harbors.
If you're a founder, the short version is: negotiate the headline valuation with investors, but let an independent, qualified valuer set the common stock value you grant options at, and refresh it whenever something material happens.
409A valuation methods, in plain English
A 409A valuation works in two steps. First, value the whole company (equity value) using the income, market or asset approach, often by backsolving from the price of a recent preferred round. Second, allocate that value across share classes to find common stock's fair market value, using the current value method (CVM), an option pricing method (OPM), a probability-weighted expected return method (PWERM) or a hybrid. A marketability discount then usually applies to common.
| Allocation method | Idea | Best when |
|---|---|---|
| CVM | Value as if the company were sold today, paying preferences first | Exit imminent, or value well below preferences |
| OPM | Treat each class as a call option on equity value | Early stage, exit timing and value uncertain |
| PWERM | Probability-weight specific exit scenarios | Later stage with visible exit paths |
| Hybrid | PWERM scenarios with an OPM inside one or more | Mixed visibility |
See what the report shows and how rounds feed the model.
Where OKtoLend fits
OKtoLend's valuation work covers 409A valuations alongside SBA lending valuations and purchase price allocations. A 409A from us is a written report reflecting the regulation's factors, prepared independently of the company's investors and auditors, and signed by a credentialed valuation analyst. Tell us your stage and capital structure and we'll reply with pricing and timing within one business day.
This guide is general information, not tax advice; work with tax counsel on grant timing, documentation and any correction of past grants.
Common questions
What happens if options are priced below fair market value?
A discounted option can be treated as deferred compensation that fails Section 409A, which can make the holder owe income tax at vesting plus an additional 20% tax and interest. Confirm specifics with a tax adviser.
How often do I need a 409A valuation?
The independent-appraisal safe harbor covers valuations dated no more than 12 months before the grant, and the valuation must reflect material information that arises after its date. Many companies update annually and after financings or other material events.
Can the founder or CFO do the 409A?
The illiquid start-up safe harbor allows a valuation by a qualified person, generally with at least five years of relevant experience, if conditions are met. Many companies use an independent appraiser to rely on the first safe harbor.
Is a 409A the same as the preferred stock price?
No. Investors usually buy preferred stock with rights common stock lacks, so common stock's fair market value is typically lower. The 409A allocates value between classes.
What's pre-money vs post-money?
Post-money = pre-money + new investment. If investors put in $2 million at an $8 million pre-money, post-money is $10 million and they own 20%.
Related guides
Sources
This guide explains rules and practice in plain English. It isn't legal, tax or credit advice, and SBA and IRS rules change. Check the current SOP, regulations and your lender's requirements before you rely on anything here. Examples with made-up businesses are illustrations, not real deals.